freemium

That is going to be the ceiling on your freemium conversion rate. That is the percentage of users who will ever pay anything. The rest will remain free users for ever. This number should sound familiar to you. That is the number most start with as we have seen in early examples, Evernote, Dropbox, LogMeIn and countless other apps. And it appears that is the number most freemium businesses end up with as well.

There is no data to support the claim that, “just wait for users to fall in love and start paying for it”. Or to the claim, “more will pay up to buy goodies and add-ons”.

Where is the data for my claim you ask? Well we do not have extensive data on every freemium startup that started five years ago. Most die out or do not make significant enough cash to join unicorn clubs on valuation. We are going to look at the data on two of the biggest winners – one who had an exit and other with known private valuation.

King Digital, the maker of Candy Crush genre of games with freemium model went public and last week was acquired by Activision for $5.9 billion. That is a valuation number that is tad lower than its IPO day an year ago. And a key metric reported is most users are not paying a dime and the percentage who spend remains 2.5%.

Dropbox has a private valuation of $10 billion. It reportedly has 400 million users but only 150,000 paying customers. Considering these are businesses, if we give a generous number of 50 paying users per business and add a few more for personal users, we still hit a number of just 2.5% paying customers. All of Dropbox future revenue growth is not going to be from covering free users but from a focused enterprise product and GTM strategy (which Box did 3 years ago).

If the percentage of paying customers top out at 2.5, what options do freemium businesses have?

They do the only thing they know is revered in the startup space – they grow. They spend more on customer acquisition. They hire growth hackers. All in the hope of keep finding 2.5% in every million users they add.

You would think after the first 10 million users they will understand segments, value and pivot to a better product and pricing strategy.

Unfortunately that sounds boring and defeatist compared to the sexiness of growth hacking. Hack all you want, as King Digital acquisition says there is only so much value market assigns to user growth that hardly pays anything.

In that article I shared some perspectives of Christian Vanek, CEO of SurveyGizmo, who then had gotten rid of freemium and strongly believed in charging for value.

That was then. This is now. Last week SurveyGizmo made news headlines by announcing a free version that offers unlimited survey question and responses. What does this mean to freemium? Are we seeing its resurgence among startups that are looking at all options to drive growth? Did my case fall apart because of SurveyGizmo’s decision reversal?

I recently shared my outsider view of why SurveyGizmo went back on its stated position and introduced free version alongside paid versions. To get a better perspective and understanding I virtually sat down with Vanek to quiz him on this change and his overall pricing philosophy.

At the outset nothing materially changed on his views of freemium nor is he giving up customer segmentation. What he shared with me, showed his vision, his approach to pricing and how transparent he is in teaching others his methods. You can see from Vanek’s explanation below, this is not freemium as it is customarily defined. It is a free version for a segment that will never pay for a survey tool.

What are the takeaways from SurveyGizmo pricing and its adoption of free?

Pricing starts with customers – It is never about you or the competition. You start with what customers seek to do, what their options are, how do they buy and what is their budget. All these factors vary across different customers. In SurveyGizmo case some are just looking for a simple response collecting tool, while those with research tasks are looking for a sophisticated survey tool. Failure to understand this difference will result in disappointment for all.

Those who seek free has many options – When you chase those users who prefer free you risk being compared against all those options and lose the opportunity to show differentiated value to your customers.

Customers do not know the right price – This may sound as contradiction to the first point but it is the other side of the same coin. While pricing starts with customers they do not know what is the right price to pay for a product. They look for value clues and specifics like services offered with a product. They are influenced by nudges like High-Low pricing that shows a high price with strikethrough and a discounted lower price.

Free is not secret to growth – SurveyGizmo recognizes growth is oxygen for a startup but free is not the path to it. They model almost zero lifetime value for those who choose free. “Very few if any of these users will upgrade”, says Vanek. If you understand the free users will not upgrade, there is no opportunity cost of lost revenue or reference price when it is time to upgrade.

Understand all the costs of free– When they had free version SurveyGizmo found it cost them significant amount to support those users even though the marginal cost in software is zero. That meant degraded experience for paying customers or adding more costs with no return. A service model innovation, leveraging communities, took away all these costs to support free users. So they decided to reintroduce free.

Use Free only to be part of conversation – The reintroduction of free was carefully decided not as growth source but to enable SurveyGizmo be part of the conversation. When people Google for “Online Survey tools” Survey gizmo is in the top 3 results. Offering the free version enabled them to be in the consideration set of those searching and increase awareness among others.

Practice the right type of free – SurveyGizmo understands most who use a free survey tool use it in its simplest form. They want to ask 2-5 questions and get just about 100 responses. So they opened up both those dimensions and made no limits on number of questions or responses. The professional survey writers value advanced features like question logic and response error checking. These features are not offered in the free version so those who are willing to pay for the product are not tempted.

Offer optimal versions – SurveyGizmo had just one version at a fixed price of $50. That was attractive to its existing customers but turned away new customers who were willing to pay but not the high fixed price. So they replaced that with a $22 and $85 versions.

Always be experimenting – Vanek understands pricing is never done and it is not something we will all understand completely. The right approach is to be willing to change and always be experimenting to find the right price that delights customers and supports your business.

Do not jail in customers – Pricing and licensing should never be about making life difficult for customers. If customers try to downgrade to free version from paid version, allow it. Make it easy for them to do business with you and do not use guards to fence them in.

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TLDR – The title says it all. This is not scattershot approach of freemium.

My all time popular article – most read, tweeted, commented – is the one on Freemium I wrote for Gigaom. That article begins with a quote from Christian Vanek, CEO of Boulder based SurveyGizmo. I will always have a soft corner for SurveryGizmo because it is from my adopted hometown of Boulder. And it is an amazing survey tool with great UX.

Three years ago, in my telephone interview Christian shared this with me (I encourage you to read the full interview as it shows how transparent and forward is Christian in his thinking)

“We are now seeing the end of the freemium model — signing up users for free and trying to upsell,”

SurveyGizmo knows pricing is not static and it needs to constantly iterate to align with changing customer mix and needs. Yesterday they announced a free version that has no limits on questions and responses. What does this mean to its stated segmentation strategy? Is freemium back? I did not get to talk to Christian on this but I posit this is not fall back to scattershot approach of freemium but a carefully chosen pricing strategy to account for change in customer mix.

Here is a view of what its current pricing looks like.

In addition to a free version there are now 3 versions. Contrast that to their single pricing option they had in the past.

And prior to that the choice of three versions.

Now it may appear they are not only back to where they started but also introduced a free version which could be seen as adoption of freemium.

Here is why I believe they did it and why it makes sense

There is abundance of general purpose survey tools for casual users – hobbyists, bloggers and the rest. You cannot compete for this category nor can you expect them to pay.

Will these casual users ever become paying customers? Highly unlikely but the cost to serve them is almost nothing and there is value in using them as test subjects for many new experiments and product features.

Serious users start with a decision problem, conduct exploratory step to build hypothesis to test then conduct a meticulous survey. These users need more sophistication from the tool.

All the feature that serious users value – input error checking, adding logic and control to the flow, rules etc. – are available only in the next tier.

Of these serious users who is willing to pay for a superior survey design, there is a certain class that is satisfied with basic support while another that is willing to pay for faster and better support experience. For the second class there is a premium priced version at $85.

Overall I believe this is pricing done right based on customer segmentation. The goal is not to get bunch of free customers and hope they will upgrade but to keep SurveyGizmo in the consideration set for many serious users by increasing its awareness among all users.

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Is that enough buzzwords packed into single title? I bet I do not have to explain what is freemium or what is disruption, two of most overused words these days. Segmentation however is not new, in fact a very old concept, and yet it is not as popular and needs explanation.

Segmentation: I am not talking demographics based indirect segmentationhere but the right way of segmenting based on customer needs (or needs based segmentation). You are grouping together customers based on the similar jobs they are trying to get done. (see here and here for more details)

When you identify customer segment and the common job to be done, understand the alternatives, surface their willingness to pay for the job, and map the budget from which those customers will pay for that job, you have marketing and product strategy.

Four years ago, when Om Malik of GigaOm wrote, “How freemium can work for your business”, I called out the cognitives biases in looking only at successful businesses.

Fast forward to present day and let us look at one of the poster boys for the freemium model, Dropbox. We have seen numbers on how Dropbox can be profitable with just 3% of the user base converting to paying customers. Small percentage of a very large number is still a large number is the thinking.

Om Malik recently did a fantastic research report on their business and growth. In his report he found,

(Dropbox), according to sources close to the company, is rumored to be valued at more than $4 billion and is on its way to a billion dollars in revenue. It has about 200 million accounts and about 4 million of those are businesses.

The numbers speak loud and clear where their success is coming from -segmentation. While both consumers and businesses may have the same job to be done (easily sharing information in a safe and secure way) one segment values it more and has almost no alternatives compared to the other segment. And it also has a budge to pay for it.

If we assumed businesses chose only the Pro edition at $99 a year with just two users (over the business edition at minimum of $795/year) that comes to 5 million business customers. If we take 4 million number from Om Malik’s report that would imply businesses with average number of users of 2.5 (generating $250 a year).

In other words, we can explain almost all of Dropbox’s $1 billion a year revenue from its business customers – those with a job to be done that is hard to be filled by alternatives and have a budget to pay for the job. You and I, consumers, do not have a budget we set aside for such services.

If they were to increase the average number of users per business to 4, even with no change in 4 million number, their run rate will jump to, $1.6 billion. If they were to target businesses with more than 5 users (and there are many if you look at US Census site), their revenue rate will rise very quickly to $5 and $8 billion.

That is Dropbox’s $1 billion run rate and its valuation are supported not by its freemium but by its segmentation strategy. Freemium may have captured everyone’s attention but it is segmentation strategy that is driving Dropbox’s success.

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In a long essay defending the importance of paywalls, Harper’s Magazine’s John MacArthur wrote this,

I can’t quite believe my ears at the nonsense still being peddled by the advocates of free content.

I can see his anger what he must be feeling to hear new media Gurus (aka charlatans) advise him and every other content creator why giving away content to attract more readers is the new reality. MacArthur is in his rights to be incensed by such business advice from those who do not know what marketing or value creation is. However my support to his argument ends there.

If Gurus make a nonsensical case based on marginal cost of digital content, MacArthur commits the same mistake based on his cost (fixed cost) to produce and distribute quality content.

Why doesn’t Harper’s give away a particularly good investigative piece (such as Ted Conover’s powerful undercover report in May on an industrial slaughterhouse) so that more people will read it?

This cost based argument justifying charging for content is same as marginal cost argument asking for it to be free. We cannot ask customers to pay for content or anything else because we have costs. See this for how ridiculous such an argument sounds.

You charge for a product as your fair share of the value you created for your customer. The fact that it costs you to edit, write and pay writers is your concern, not customers’. If the content you create is no different from many other options or adds no perceived or real value to the customers then they will have no reason to pay for it.

MacAcrthur takes his argument even a step further and making it an argument about fairness,

This photographer, who requested anonymity, risked arrest and prison to take excellent pictures — as do other photographers such as Samuel James — for the benefit of Harper’s and you. The censors in Tehran are surely upset. Shouldn’t Anonymous be paid for this courage and skill? Shouldn’t Harper’s be compensated for sending Anonymous into the field?

Do not try answering his questions because they are irrelevant. People take risks because they see payoff at the end and are willing to trade-off risk and reward. If the photographer believes his content will be just another commodity and will only be valued thusly by his customers (publishers and readers) he would not be willing to take the risk.

It is not that the Anonymous must be paid for courage and skill but Anonymous is showing courage and skill because he sees opportunity to get fair share of differentiated value he creates through this courage and skill.

And definitely Harper’s cannot expect to be compensated for sending Anonymous. It your risk and your risk alone.

Let me start by reiterating my past objections about giving Apps away for free in the hope of getting attention now and monetization later. Call it by whatever portmanteau you wish – freemium etc. or use the justification that free is free marketing. It does not matter if customers are not hiring your App for a job they are willing to pay for and you do not take the time and effort to understand customer jobs and position your App for the right job.

The App economy tempts us all with billion customers – small percentage of a large number is still a large number. But trying to target billion customers is what SurveyGizmo CEO described as shotgun approach to marketing.

And guess what? You are not the only one with the same shotgun – the App ecosystem has made the same shotgun available to everyone. There are many just like you and their App just like yours with the same hope of converting the same 1-2% of users into paying customers.

With hundreds of thousands of games, productivity tools and other apps already on the market, and thousands more launched every week, many startups are finding that their ideas aren’t so unique after all. (source)

With all these thousands of look alike Apps, the small percentage of large number becomes small fraction of the small percentage of a large number. Which I assure you is a really small number.

The odds of striking gold in the apps business are quite long. While there are more than 800,000 mobile apps available in Apple Inc.’s App Store, only 80 of them generated more than $1 million in revenue during the fourth quarter, according to research firm Distimo

That is the chances of an App making $4 million a year is 1 in 10,000. And there is no point in trying to do expected value math here because the winner takes it all.

And it turns out Free is not even close to free marketing or to be precise marketing is not free even for free Apps. If you want any thing close to decent installs (let alone frequent usage) it takes considerable marketing resources.

It gets worse than Free – you end up paying users to install and tell others about the App as the App maker Mouthee found out

Mouthee ran promotions—giving out free iTunes gift cards or other gifts to users who signed up their friends—which would bring a spike in downloads, but the boost would taper off after a week or so,

Let us recap the App situation

There are hundreds if not thousands with App just like yours

They are free as well

Free isn’t free marketing and marketing isn’t free

Building passionate user base is a myth and the chances a newbie App maker without marketing resources will make it into Top 250 is less than 2%

Chances your freemium App will make $4 Million a year is 1 in 10,000

Finally even when you gain millions of installs, your users can stay on free version longer than your startup can stay solvent,

There are so many startups that die with a whimper

Do you still believe freemium has not run its course?

Cast aside these fads and start with the business first principles to go from plan to profit.

Start with the customers, not your App. The App could be new but the customer needs are not. Whether it is a “bits” product with zero marginal cost or “atoms” product with non-zero marginal cost, customer needs come first. In fact, it is not a product until you have identified a set of customers whose needs you meet and who want to pay you for that value.

Make your choice. Successful strategy involves making choices. You cannot treat billion users as customers. Getting 90 percent of customers to take free Hershey’s chocolates with the hope that they will pay more for extras or will upgrade later is not a strategy.

Get your fair share of the value created. Charging for the product is still the simplest of all business models. Product and platform innovation do not mean business model innovation like freemium (which should never be called a business model). If your product adds compelling value to customers, charging for it is simply getting your fair share of the value created. You do not have to be ashamed of making a profit.